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An Internet depression may be lurking

NEW YORK (AP) -- Here be dragons. That's how Business Week economics editor Michael Mandel sums up his argument that we rest on the cusp of an Internet Depression.

It's an argument that, even in this age of doom-and-gloom economic tomes, is worthy of pause, especially as the Fed prepares to weigh in on interest rates this week and the Nasdaq has fallen below 3,000 for the first time in a year.

In ''The Coming Internet Depression'' (Basic Books, $24), Mandel warns that the very technological boom that led to the U.S. economy's unprecedented expansion carries with it a potentially wicked kick.

Mandel argues that the willingness of the market to fund speculative companies that seek out innovations with the promise of rich rewards -- a situation almost unique to the United States -- helped bring the New Economy to the forefront here.

We see this through venture capitalists, who have funneled billions of dollars from pension funds and other investors into high-risk businesses; through initial public offerings, which have allowed companies such as Amazon.com and Priceline.com to implement their business plans; and through workers, who are willing to take part of their payment in stock options.

But what happens when it starts going sour? What happens when venture capitalists can't find anything they want to sink their money into, and subsequently head for safer havens to ride out the turbulence? What happens when the IPO market dries up? What happens when all those workers who have been receiving payments in stock options start demanding cold cash from their companies -- that is, if the companies still exist?

Mandel argues that the ensuing spiral could begin to feed upon itself, driving the market lower and lower and creating a momentum that will overcome the current ''buy on the dip'' mentality that has kept the market afloat. Meanwhile, inflation, which has been kept low because of productivity and competition, begins to resurface.

Other factors come into play. For example, foreign investors, attracted to the security and wealth offered by the United States, begin to head elsewhere. That hurts the markets even more, which causes additional retrenchment.

All this will happen over time, not in a one-day crash, Mandel opines. How bad the spiral becomes, he adds, depends on how the government responds -- in particular, the Federal Reserve.

What's needed to stem the decline is a move by the Fed to lower interest rates, which will keep the economic engine humming. But if the Fed responds by raising interest rates (to help knock down inflation), it could be a long time before growth returns.

Mandel is fuzzy about when all this might happen. But even as Alan Greenspan et al. attempt to chart a so-called soft landing, we're already seeing some worrisome signs.

The market continues to be punished, with poor results by Dell and Hewlett-Packard sending tech stocks spiraling downward. Internet companies are dropping like flies -- among the latest to fall, Pets.com and its sock puppet.

So far, venture capitalists continue to pump billions into companies. Still, the PricewaterhouseCoopers Money Tree survey, released this week, says third-quarter funding reached $17.6 billion, down from $19.8 billion in the second quarter. It's the first time in seven quarters there hasn't been a quarter-on-quarter increase.

OK, it's easy to hype a worst-case scenario; publishers don't pitch books to the public offering more of the same. But perhaps Mandel's most accurate assessment of the situation is that we have entered uncharted territories. After all, economists in general didn't foresee the Internet boom.

''Nobody has ever seen how Amazon.com, eBay or any of the deregulated telephone companies behave in a real tech recession,'' Mandel writes. ''Nobody knows how an economy built on information technology and rapid innovation will react to a sharp downturn.''